While economic surprise indices may now be rolling over, US earnings forecasts for 2017 are effectively unchanged since January. In the UK and continental Europe forecasts have risen relatively sharply since the start of the year, reflecting in the UK a continued tailwind from sterling weakness and in continental Europe the long-awaited improvement in economic activity.
In the short-term earnings momentum is a key driver of sector performance, as demonstrated in 2015 when basic resources and energy estimates fell consistently, leading in turn to considerable sector volatility. While we still have concerns in terms of equity valuations in general, thus justifying a cautious overall outlook for global equity markets, there is in our view likely to be near-term support around current levels (absent a major shock), for as long as earnings forecasts remain stable.
However, we would inject a note of caution when interpreting the weighted average earnings revision indices for 2017. As shown in Exhibit 2, on an median basis, these regions have shown varying degrees of positive momentum in the year to date. Continental Europe has continued to deliver positive surprise while the median US and UK 2017 earnings estimate has been on a downward trend since the start of the year. The consistency between the weighted average and median measure in continental Europe suggests that something more pronounced may be underway.
Furthermore, the equal-weighted earnings growth forecast for 2017 remains between 8-11% in each of the US, UK and continental Europe, Exhibit 3. As in prior periods, the actual out-turn is likely to be somewhat lower, but even so this forecast is well ahead of 2016, where at the same point in the year forecasts were for earnings growth of 7% in the US and UK – and merely 4% in continental Europe.
Therefore while there is a coherent case for investment caution due to relatively high equity market valuations at present (particularly in the US), not all the data points in the same direction. Although we judge that overall a cautious outlook remains warranted based on elevated Price/sales and Price/book multiples, stable earnings forecasts are likely to reassure P/E-based investors relying on a 2017 earnings growth figure in the region of +10%.
In continental Europe, the rising trend for earnings forecasts is consistent with the improved economic data for the region over the last 9 months. There may be the potential for markets to become excited about a virtuous circle of improving economic data, combined with receding financial and political risks.
Certainly this is consistent with the very strong inflows seen into European equity funds in recent weeks. However, in our view this virtuous circle is at least partly factored into continental European equity markets which have enjoyed a robust performance of close to 20% in euro terms over the last 6 months.